Wednesday, September 5, 2012

Despite the ECB's rhetoric on defending the euro that pushed up global risk asset valuations, the underlying issues of the Eurozone have not been resolved. Signs of the run on Spain's banks are once again in the press. Previously we had Der Spiegel describe the enormous euro deposit outflows from the Spanish banking system (see post). The problem has not gone away and here is an update with some explanations (in italic).

WSJ: - The latest trouble is the inability of Spanish banks to finance themselves through usual means. Capital markets remain largely shut because investors refuse to buy bank bonds at affordable prices. And customers, nervous about the banks' health, are increasingly yanking their deposits.

The banks appear to be exhausting their capacities to wring cash out of the European Central Bank, the lender of last resort for much of Southern Europe's battered financial system [see this discussion on how the National Central Banks fund this lending].

The problems have been building since last fall. But the recent intensification has sent Spanish officials scrambling to prevent their banking system's liquidity problems from escalating into an acute financial crisis. Many experts expect the ECB to ride to the rescue on Thursday by making it easier for euro-zone banks to borrow money from it. [the only way it can make it easier is by loosening the collateral requirements]

In one sign of the mounting pressures, the Bank of Spain appears to have started providing emergency loans to some of the country's banks, according to central-bank data and industry officials [this is alarming because it means that some Spanish banks have run out of eligible collateral].
...

Now the collateral problem is rearing up again, with analysts saying some Spanish banks are running low on eligible assets. [see this discussion on how Spain has been desperately trying to come up with new forms of structured securities collateral]

UBS's Alastair Ryan reckons that the Spanish industry is holding a total of about €169 billion of government bonds that could serve as collateral for ECB loans, but that masks the fact that, individually, some lenders have a shortage of collateral. Other assets, such as mortgages, already have been deployed in covered bonds and other securities, so aren't available for future borrowings, Mr. Ryan said.

Emergency lending has been used by Ireland (discussed here) and by Greece (discussed here). This is the first indication that Spain's central bank is now deploying this program as well. It explains the urgency behind Rajoy's visit to Germany to expedite Spain's bailout. He wants to make sure if he asks for support, Germany isn't going to block it.

Reuters: - "The worst thing that could happen is Spain asks for aid and Germany blocks it," said a senior European diplomat.

Last week Rajoy met French President Francois Hollande who nudged him to ask for help before October to give European leaders time to consider it before an Oct. 19-19 summit.

But Rajoy told Hollande he was getting mixed messages from Germany, according to a source who was briefed on the meeting.

Berlin wants more details of the problems in Spanish banks, including the results of an audit by global accounting firms due later this month, and regions, which will get 45 billion euros from Spain's central government this year, before backing a bailout.

Spain has already been promised up to 100 billion euros of European money to keep its banks afloat. A sovereign bailout could deplete the region's rescue funds, the EFSF and the new ESM that will be the euro zone's permanent rescue fund.

And all this needs to happen fast - before Spain's government budget trajectory (see this discussion) becomes unacceptable to the ECB and the backers of the bond-buying program (particularly in Germany). Signs of budget plans being derailed are already there.

The Guardian: - Increased unemployment benefit payments are already putting pressure on Rajoy's budget plans, with figures released on Tuesday showing a 5% increase for the first seven months of the year. The budget minister, Cristóbal Montoro, had predicted that benefit payments, which fall over time for the long-term unemployed, would actually come down by 5% this year.

It's difficult to overstate the urgency of Spain's predicament. If the ECB falls short of discussing the full plan for securities purchases this Thursday (with sufficient amount of detail), periphery bonds and other risk assets will see a sharp selloff. Expectations are high and market participants could be in for a disappointment.